Q&A: An Overview of the Inflation Reduction Act’s New Credit and Incentive Opportunities

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For this edition, I invited my colleague?Mike Stavish, Managing Director in BDO’s Tax Credit Investment Services practice, for a conversation about the Inflation Reduction Act’s changes to renewable energy credits and incentives. Read on to learn how these credits and incentives could help lower your total tax liability and advance your ESG strategy.?

Matt: Thanks for joining me today, Mike. The Inflation Reduction Act is the largest climate investment in U.S. history and opens the door to many new tax credits, while making some significant changes. Can you walk us through the major changes to clean energy credits introduced in the law?

Mike: Thanks Matt, great to be here. What’s important to know is that the Inflation Reduction Act introduces three major changes. The first is that it creates new opportunities to monetize credits. Tax-exempt entities can now monetize credits through direct pay, and taxable entities can make an election to transfer credits — essentially creating an open market for these credits. The second is that it extends existing clean energy tax credits by 10 years, allowing organizations to plan for the long term, and provides tax credits for new technologies such as standalone battery storage and clean hydrogen. And the third is that it introduces a tiered structure, where businesses may be eligible for a base credit and then a bonus credit of up to five times the base amount if certain prevailing wage and apprenticeship requirements are met. There are also additional bonus credits for incorporating domestic content, as well as building new projects in energy communities or in low-income communities. With new structures for monetizing and transferring credits, these credits are now applicable to many more businesses, not only energy companies.

Matt: That’s great that more companies can now take advantage of these credits and extending them certainly helps for long-term planning. Can you talk a little more about how the market for exchanging credits might take shape?

Mike: Yes, so to be clear, the market for transferring credits is not yet established, as this option does not begin until 2023. It will be interesting to see what buyers are willing to pay for these credits. However, we expect credits backed by thorough documentation, demonstrating that credit requirements were achieved, will likely transfer at the highest rates.

Matt: What kind of documentation is required? Can you share an example?

Mike: Certainly. For example, if a company is transferring a 30% Investment Tax Credit, it will need to demonstrate that it has met the prevailing wage and apprenticeship requirements in its project to obtain the 30% bonus credit, in order to secure a buyer. Buyers should do their own due diligence to ensure the requirements have been met. They don’t want to end up in a situation where they have paid for a 30% credit but then find out underlying requirements have not been met and they can only claim the base credit of 6%.

We are likely going to see demand for third parties to validate credits before they are sold and potentially support the eligible costs with a cost segregation as well. It will be interesting to see how the market evolves with time.

Matt: Yes, that’s certainly interesting to think about, and I imagine rigorous documentation is going to play an important role. Taking a broader view, how can companies use these credits to advance their ESG strategy?

Mike: Yes, that’s a great question. When a company purchases credits, they are providing capital that helps fund new renewable energy projects, which companies can cite as part of reporting on ESG goals. Purchasing credits should not be the only action companies take around ESG, however, and it alone may not fully satisfy stakeholder expectations.

Matt: Right, well certainly one goal of the legislation is to encourage companies to invest in clean energy. Is there anything else important from the bill for businesses to keep in mind?

Mike: Yes, so you mentioned the goal of the legislation is to promote investment in clean energy. Another goal is to support U.S. jobs, U.S. industry and develop high-paying green careers. That is where the domestic content credit and prevailing wage and apprenticeship bonus credit comes into play. Determining whether to pursue the domestic content credit is going to be a mathematical exercise. Businesses will have to weigh whether it is economical to use domestically produced materials in their projects to qualify for the 10% bonus credit.

The IRA also extends a credit for advanced manufacturing facilities, under Section 48C, allocating up to $10 billion more in awards for qualified investments. It also introduces a new production tax credit, under Section 45X, for manufacturers of components used in the production of clean energy. These new credits provide incentives for companies to buy from U.S. manufacturers and for manufacturers to onshore production to the U.S. Onshoring production, especially for high-tech, complex manufacturing, is costly, and the availability of new credits may help spur domestic investment.

Matt: Makes sense. There are a lot of factors to watch to see how this legislation will play out. I appreciate your insight, Mike.

Mike: Thanks for having me, Matt.?

Matt: If you’re interested in learning more about what credits in the Inflation Reduction Act may benefit your business, contact us here.